Watch what they predict, not what they say

Lots of commenters make a big deal about the fact that some Fed officials, and Ben Bernanke in particular, often make statements implying that they don’t engage in monetary offset.  One response is that they also make statements implying that they do engage in monetary offset.  Talk is cheap, and there’s no doubt the Fed would prefer that Congress do more of the heavy lifting, so they could do less (and hence be less controversial.)

But actions speak louder than words.  How does the Fed change its forecast of RGDP growth in 2013, as a result of the big tax increases plus sequester?  Take a look at the following, from The Economist:

Screen Shot 2014-03-06 at 9.32.43 AM

Lots of people have noticed that actual GDP growth accelerated in 2013, as compared to 2012, despite all the austerity we were warned about.  But of course lots of unexpected things can happen over a 12 month period.  I find it much more interesting to look at the expected effect of austerity. Notice that expected 2013 growth is identical to expected 2012 growth.

Now some will argue that that’s only because other things were changing to offset the effect of austerity.  For instance, the Fed did QE3 and forward guidance in late 2012.

Which is exactly the point.

PS.  In fairness, I’m not sure how fully they understood the extent of fiscal austerity in their December 2012 forecast.  They did cite looming fiscal austerity when justifying their monetary stimulus of late 2012, so it was clearly understood that austerity would occur.  But in March they lowered their RGDP growth forecast from 2.65% to 2.55%, perhaps because of more information about the severity of the austerity.

The Fed lowered its GDP forecast slightly downward in the March FOMC meeting

The Fed is forecasting from 2.3% to 2.8% in GDP growth for 2013, taking down the top end of the range from 2.3% to 3.0%. The Committee noted that the private economy was growing a little faster than anticipated, and that would nearly offset the fiscal drag imposed by the Jan 1st tax hikes and the sequester. They did adjust their 2014 and 2015 forecasts lower as well, although not dramatically.

On the other hand Q1 growth was very weak, so it seems equally likely that that triggered the downgrade in forecasts, not the sequester.  Fiscal austerity might or might not have lowered the Fed’s growth forecast by 10 basis points.  That’s far from the apocalyptic forecasts of the Keynesians. 

When the storm is long past, the 5 year—5 year forward TIPS spreads will show 2% inflation

Keynes once said:

Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again.

Vaidas Urba sent me some interesting quotations.  First Ben Bernanke at the September 16, 2008 Fed meeting, which I propose we call the “Noah’s flood meeting,” after Hawtrey’s famous remark. Here’s Bernanke:

But it was noted that the five-by-five TIPS breakeven remains above a level consistent with long-term price stability.

Vaidas also sent me the following from the ECB:

The long-term forward inflation swap rate remained broadly stable over the period under review, standing at around 2.2% on 5 February. Overall, giving due consideration to both the inflation risk premium and the liquidity premium, market-based indicators suggest that inflation expectations remain fully consistent with price stability.

I also found this from the same ECB report:

At the same time, underlying price pressures in the euro area remain weak and monetary and credit dynamics are subdued. Inflation expectations for the euro area over the medium to long term continue to be firmly anchored in line with the Governing Council’s aim of maintaining inflation rates below, but close to, 2%. As stated previously, the euro area economy is now experiencing a prolonged period of low inflation, which will be followed by a gradual upward movement towards inflation rates below, but close to, 2% later on.

There are two very serious problems here.  First, the question of whether Fed policy has long term credibility on the inflation front is quite different from the question of whether inflation is appropriate over the next few years.  I don’t doubt that even during the Great Deflation of 1929-33 most sensible people expected the deflation to end at some point, and prices to level off or maybe even rise a bit. The Fed needs to hit its targets over the next few years, and by that criterion the markets in September 2008 showed that monetary was far too tight.  The Fed should ignore 5 year forward inflation forecasts.  Indeed they should ignore inflation entirely, and focus on NGDP growth, which was falling sharply in late 2008.

The ECB report is even worse.  It actually predicts that inflation will be well below average over the next few years, and then close in on 1.9% a few years down the road. That means they are predicting a procyclical inflation rate, which is a totally insane policy.

In the past Europeans criticized me for suggesting the ECB should deviate from their single mandate to control inflation.  (BTW, it’s a lie to claim the ECB has a single mandate to control inflation.)  OK, so now even the ECB admits their policy will allow inflation to deviate from the target, and then gradually return to the target.  So they are flexible.  That should make me feel better, but then we find out they are flexible in exactly the wrong way.  A flexible inflation targeting regime calls for below average inflation when the economy is booming, and above average inflation when the economy is weak.  They plan to do the exact opposite!

The ECB is basically saying;  ”We plan to continue screwing up economic policy for a few more years, but don’t worry, sometime late in the decade we’ll have an appropriate monetary policy.”  I’m sure the Greeks will be glad to hear that.

PS.  I got far behind on comments, but did respond to a few in the past 5 posts this evening.  I also have a Econlog post, if you are interested.

PPS.  Vaidas noticed the Europeans making the same mistake as the Fed made in 2008.  There is an old Chinese curse “May you live in interesting times.”  (I believe it’s apocryphal.)  How about “May you live in a large diverse economy overseen by a ‘teenager’ central bank.”  The Fed was 15 years old in 1929.  The ECB is now 15 years old.

PPPS.  My daughter will be 15 this year.

How much longer?

Some questions for various old monetarists, Austrians, gold bugs, and other conservatives:

1.  Japan has had interest rates near zero for nearly 2 decades.  Is this easy money, despite an NGDP that is lower than in 1993?  Despite almost continual deflation?  Despite a stock market at less than one half of 1991 levels.  Despite almost continually falling house prices?  If it’s easy money, how much longer before the high inflation arrives?

2.  The US has had near zero interest rates for more than 5 years.  Is this easy money?  If so, how much longer until the high inflation arrives?  If rates stay near zero for 2 more years, and inflation stays low, will you still call it easy money?  How about 5 more years?  Ten more years?  Twenty?

I constantly hear conservatives complain that elderly savers can’t earn positive interest rates because of the Fed’s “easy money” policy.  Is there any time limit on how long you will make this argument, before throwing in the towel and admitting rates are low because of the slowest NGDP growth since Herbert Hoover was President?  Or is your model of the economy one where decades of excessively easy money leads to very low inflation and NGDP growth?

In other words, is there some sort of model of monetary policy and nominal interest rates that you have in your mind, or do you see easy money everywhere and tight money nowhere?  What would tight money look like?  What sort of nominal interest rates would it produce?

Mark Sadowski on monetary stimulus, currency depreciation, and trade balances

Before beginning, let me point out that many people seemed to misread my previous post.  I was making no claims about causality.  God knows I’m no expert in criminology!  I was making a joke about people with a certain blind spot—incentive effects.

Over at Econlog I have a post discussing Edward Hugh’s recent piece on Abenomics.  At the end I cited a comment by Mark Sadowski.  This post will be another of his excellent comments:

Scott,
Off Topic.

This claim by Edward Hugh reveals he really doesn’t get it.

http://fistfulofeuros.net/afoe/the-growing-mess-which-will-be-left-behind-by-the-abenomics-experiment/

“But it’s worse, the monetary expansion has driven down the value of the yen but in the context of the second arrow – a double digit fiscal deficit – this drop in value is leading to a growing not a declining trade deficit. The FT’s Tokyo bureau chief, Jonathan Soble, has an enlightening recent piece on this…”

Although Japanese nominal exports have surged by 15.2% between 2012Q4 and 2013Q3, nominal imports are up by even more, or by 16.5%:

http://research.stlouisfed.org/fred2/graph/?graph_id=149566&category_id=0

Devaluation improves a country’s trade balance only if the Marshall-Lerner condition on trade elasticities holds, and research shows that they’re not met in the majority of cases, either past or present:

http://www.emeraldinsight.com/journals.htm?articleid=17056473

That’s not to say that currency devaluation isn’t beneficial, of course it is, but the benefit flows primarily from increased domestic demand. Here is a study of the competitive devaluations of the Great Depression by Barry Eichengreen and Douglas Irwin:

http://www.nber.org/papers/w15142.pdf

The Great Depression is a particularly important historical example because then, as now, most of the advanced world was up against the zero lower bound in policy interest rates.

An examination of Figure 4 on page 48 reveals that the only countries that experienced import growth from 1928 to 1935 (the UK, Japan, Sweden and Norway) were members of the sterling block that devalued early (1931). In most of these countries net exports actually declined over the period because imports rose more than exports.

The order of recovery from the Great Depression follows the order in which they abandoned the gold standard perfectly:

http://fabiusmaximus.files.wordpress.com/2009/03/gold.png

But this wasn’t because of increased net exports.

The US devalued in 1933 which immediately led to a swift recovery from the Great Depression. Nominal exports doubled from 1933 to 1937. But nominal imports increased by 110.5%:

https://research.stlouisfed.org/fred2/graph/?graph_id=120991&category_id=0

As a result net exports went from a small surplus (about 0.2% of nominal GDP) to being roughly in balance.

France was part of the Gold bloc of countries that devalued late (1936). From 1936 to 1938 nominal exports increased by 95.4% and nominal imports increased by 80.9%:

https://research.stlouisfed.org/fred2/graph/?graph_id=120992&category_id=0

However, since imports were already substantially greater than exports, the nominal deficit actually increased by 55.4%.

Japan’s original ryōteki kin’yū kanwa (QE) was officially announced in March 2001 and concluded in March 2006. The following is a graph of the BOJ’s estimate of Japan’s real effective exchange rate which is trade weighted with respect to 16 different currencies and takes into account their relative inflation rates:

http://thefaintofheart.files.wordpress.com/2013/06/sadowski2b_1.png

The real effective exchange rate fell from 116.25 in February 2001 to 91.09 by March 2006, when the BOJ announced the completion of QE, a decline of 21.6%.

Exports rose from 10.2% of nominal GDP in 2001Q4 to 19.3% of GDP in 2008Q3. Imports rose from 9.4% of GDP in 2001Q4 to 19.5% of GDP in 2008Q3. From 2002Q1 to 2008Q1 real (adjusted by the GDP implicit price deflator) grew at an average annual rate of 11.0%. Real imports grew at an average annual rate of 12.1%.

So there was boom in both exports and imports. But imports grew faster than exports, and net exports actually moved from surplus (0.8% of GDP) to deficit (-0.2% of GDP) between 2001Q4 and 2008Q3:

http://research.stlouisfed.org/fred2/graph/?graph_id=120989&category_id=0

It’s very telling that today the only major currency area up against the zero lower bound in interest rates that hasn’t done QE (the Euro Area) is also the only major currency zone where the trade balance has improved substantially since 2009, going from 0.6% of GDP in 2009Q1 to 3.3% of GDP in 2013Q3:

https://research.stlouisfed.org/fred2/graph/?graph_id=149559&category_id=0

But this has occurred in large part because nominal imports have been falling since 2012Q3 due to falling domestic demand. Nominal exports have barely changed since 2012Q3.

I’d add that Greece has done an especially good job of “improving” its trade balance.

American progressives, incentive effects, blind spots

Here’s George Will back in 2008:

Listening to political talk requires a third ear that hears what is not said. Today’s near silence about crime probably is evidence of social improvement. For many reasons, including better policing and more incarceration, Americans feel, and are, safer. The New York Times has not recently repeated such amusing headlines as “Crime Keeps on Falling, But Prisons Keep on Filling” (1997), “Prison Population Growing Although Crime Rate Drops” (1998), “Number in Prison Grows Despite Crime Reduction” (2000) and “More Inmates, Despite Slight Drop in Crime” (2003).

George Will spoke too soon.  If it’s really a blind spot with progressives then they won’t be able to stop even if they try to, because they aren’t even aware of what they are doing.  Tyler Cowen directs us to another example from the New York Times:

What is happening in America today is both unprecedented in our history, and virtually unique among Western democratic nations. The share of our labor force devoted to guard labor has risen fivefold since 1890 — a year when, in case you were wondering, the homicide rate was much higher than today.

Yup.  I was wondering was life was like before we had lots of guards.  Thanks for telling me.